Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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**(Mark One)**

 

**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended September 30, 2010**

 

**OR**

** **

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For thetransition period from                to                 **

 

**Commission File Number 001-33993**

 

**CardioNet, Inc.**

(Exact Name of Registrant as Specified in its Charter)

 

| **Delaware**                                                   | ** ** | **33-0604557**                          |
|----------------------------------------------------------------|------------|-----------------------------------------|
| (State or Other Jurisdiction of Incorporation or Organization) |       | (I.R.S. Employer Identification Number) |

 

| **227 Washington Street  Conshohocken, Pennsylvania** | ** ** | **19428**  |
|-------------------------------------------------------|------------|------------|
| (Address of Principal Executive Offices)              |       | (Zip Code) |

 

**(610) 729-7000**

(Registrant’s Telephone Number, including Area Code)

 

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post suchfiles).  Yes o  No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer o                     |   | Accelerated filer x         |
|-----------------------------------------------|--------|----------------------------------|
|                                          |   |                             |
| Non-accelerated filer o                       |   | Smaller reporting company o |
| (Do not check if a smaller reporting company) |   |                             |

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act).  Yes o  No x

 

Asof November 1, 2010, 24,229,546 shares of the registrant’s common stock,$0.001 par value per share, were outstanding.

 

 

 

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**CARDIONET, INC.**

**QUARTERLY REPORT ON FORM 10-Q FOR THE PERIODENDED SEPTEMBER 30, 2010**

**TABLE OF CONTENTS**

 
| ** **        | ** **                                                                                  | **Page  No.** |
|-------------------|---------------------------------------------------------------------------------------------|---------------|
| **PART I.**  | **FINANCIAL INFORMATION**                                                                   | ** **    |
| Item 1.           | Financial Statements                                                                        | 4             |
| Item 2.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 17            |
| Item 3.           | Quantitative  and Qualitative Disclosures about Market Risk                                 | 22            |
| Item 4.           | Controls and  Procedures                                                                    | 22            |
|              |                                                                                        |          |
| **PART II.** | **OTHER INFORMATION**                                                                       | ** **    |
| Item 1.           | Legal Proceedings                                                                           | 23            |
| Item 1A.          | Risk Factors                                                                                | 24            |
| Item 2.           | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 25            |
| Item 3.           | Defaults  Upon Senior Securities                                                            | 25            |
| Item 4.           | Removed and Reserved                                                                        | 25            |
| Item 5.           | Other Information                                                                           | 25            |
| Item 6.           | Exhibits                                                                                    | 26            |
|              |                                                                                        |          |
| SIGNATURES        | 27                                                                                          |

 

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**FORWARD-LOOKING STATEMENTS**

 

This document includes certain forward-lookingstatements within the meaning of the “Safe Harbor” provisions of the PrivateSecurities Litigation Reform Act of 1995 regarding, among other things, ourgrowth prospects, the prospects for our products and our confidence in theCompany’s future. These statements may be identified by words such as “expect,”“anticipate,” “estimate,” “intend,” “plan,” “believe,” “promises” and otherwords and terms of similar meaning. Such forward-looking statements are basedon current expectations and involve inherent risks and uncertainties, includingimportant factors that could delay, divert, or change any of them, and couldcause actual outcomes and results to differ materially from currentexpectations. These factors include, among other things, the national rate setby the Centers for Medicare and Medicaid Services (“CMS”) for our mobilecardiovascular telemetry service, effectiveness of our cost savingsinitiatives, changes to insurance coverage and reimbursement levels for ourproducts, the success of our sales and marketing initiatives, our ability toattract and retain talented executive management and sales personnel, ourability to identify acquisition candidates, acquire them on attractive termsand integrate their operations into our business, the commercialization of newproducts, market factors, internal research and development initiatives,partnered research and development initiatives, competitive productdevelopment, changes in governmental regulations and legislation, the continuedconsolidation of payors, acceptance of our new products and services and patentprotection and litigation. For further details and a discussion of these andother risks and uncertainties, please see our public filings with theSecurities and Exchange Commission, including our latest periodic reports onForm 10-K and 10-Q. We undertake no obligation to publicly update anyforward-looking statement, whether as a result of new information, futureevents, or otherwise.

 

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**PART I — FINANCIAL INFORMATION**

**Item 1. Financial Statements.**

 

**CARDIONET, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(*In thousands, except share and pershare amounts*)**

 
| ** **                                                                                                                                                                        | ** ** | **(Unaudited)**                  | ** ** | ** **                      | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                                        | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
| ** **                                                                                                                                                                        | ** ** | ** **                       | ** ** | ** **                      | ** ** |
| **Assets**                                                                                                                                                                        |       |                             |       |                            |       |
| Current assets:                                                                                                                                                                   |       |                             |       |                            |       |
| Cash and cash equivalents                                                                                                                                                         |       | $                                | 10,631     |                            | $          | 49,152 |   |
| Short-term available-for-sale-investments                                                                                                                                         |       | 32,247                           |       | —                          |       |
| Accounts receivable, net of allowance for doubtful  accounts of $12,697 and $22,396, at September 30, 2010 and  December 31, 2009, respectively                         |       | 38,066                           |       | 40,885                          |       |
| Prepaid expenses and other current assets                                                                                                                                         |       | 3,603                            |       | 2,818                           |       |
|                                                                                                                                                                              |       |                             |       |                            |       |
| Total current assets                                                                                                                                                              |       | 84,547                           |       | 92,855                          |       |
|                                                                                                                                                                              |       |                             |       |                            |       |
| Property and equipment, net                                                                                                                                                       |       | 22,693                           |       | 28,243                          |       |
| Intangible assets, net                                                                                                                                                            |       | 629                              |       | 939                             |       |
| Goodwill                                                                                                                                                                          |       | 45,999                           |       | 45,999                          |       |
| Other assets                                                                                                                                                                      |       | 480                              |       | 286                             |       |
|                                                                                                                                                                              |       |                             |       |                            |       |
| Total assets                                                                                                                                                                      |       | $                                | 154,348    |                            | $          | 168,322 |   |
|                                                                                                                                                                              |       |                             |       |                            |       |
| **Liabilities and stockholders’  equity**                                                                                                                                    |       |                             |       |                            |       |
| Current liabilities:                                                                                                                                                              |       |                             |       |                            |       |
| Accounts payable                                                                                                                                                                  |       | $                                | 5,436      |                            | $          | 7,160 |   |
| Accrued liabilities                                                                                                                                                               |       | 8,416                            |       | 9,919                           |       |
| Deferred revenue                                                                                                                                                                  |       | 383                              |       | 393                             |       |
|                                                                                                                                                                              |       |                             |       |                            |       |
| Total current liabilities                                                                                                                                                         |       | 14,235                           |       | 17,472                          |       |
|                                                                                                                                                                              |       |                             |       |                            |       |
| Deferred rent                                                                                                                                                                     |       | 1,263                            |       | 1,497                           |       |
|                                                                                                                                                                              |       |                             |       |                            |       |
| Total liabilities                                                                                                                                                                 |       | 15,498                           |       | 18,969                          |       |
|                                                                                                                                                                              |       |                             |       |                            |       |
| Stockholders’ equity:                                                                                                                                                        |       |                             |       |                            |       |
| Common stock, $.001 par value; 200,000,000 shares  authorized; 24,245,305 and 23,965,405 shares issued and outstanding at  September 30, 2010 and December 31, 2009, respectively |       | 24                               |       | 24                              |       |
| Paid-in capital                                                                                                                                                                   |       | 246,842                          |       | 242,320                         |       |
| Accumulated other comprehensive income                                                                                                                                            |       | 18                               |       | —                          |       |
| Accumulated deficit                                                                                                                                                               |       | (108,034                         | )          | (92,991                         | )          |
|                                                                                                                                                                              |       |                             |       |                            |       |
| Total stockholders’ equity                                                                                                                                                   |       | 138,850                          |       | 149,353                         |       |
|                                                                                                                                                                              |       |                             |       |                            |       |
| Total liabilities and stockholders’ equity                                                                                                                                   |       | $                                | 154,348    |                            | $          | 168,322 |   |

 

See accompanying notes.

 

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**CARDIONET, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

**(*In thousands, except share andper share amounts*)**

 
| ** **                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                             | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Revenues:                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Net patient service revenues                           |       | $                                                    | 27,486     |                                                | $          | 33,300 |   | $ | 91,241 |   | $ | 106,954 |   |
| Other revenues                                         |       | —                                               |       | 40                                                  |       | — |   | 370 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Total revenues                                         |       | 27,486                                               |       | 33,340                                              |       | 91,241 |   | 107,324 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of revenues                                       |       | 11,938                                               |       | 11,829                                              |       | 35,522 |   | 35,661 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Gross profit                                           |       | 15,548                                               |       | 21,511                                              |       | 55,719 |   | 71,663 |   |
| Operating expenses:                                    |       |                                                 |       |                                                |       |   |   |   |   |
| General and administrative                             |       | 8,717                                                |       | 9,738                                               |       | 26,942 |   | 29,754 |   |
| Sales and marketing                                    |       | 7,305                                                |       | 9,562                                               |       | 22,178 |   | 25,548 |   |
| Bad debt expense                                       |       | 4,934                                                |       | 5,642                                               |       | 14,058 |   | 14,086 |   |
| Research and development                               |       | 1,237                                                |       | 1,325                                               |       | 3,710 |   | 4,310 |   |
| Integration, restructuring and other charges           |       | 859                                                  |       | 1,150                                               |       | 3,932 |   | 3,109 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Total expenses                                         |       | 23,052                                               |       | 27,417                                              |       | 70,820 |   | 76,807 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Loss from operations                                   |       | (7,504                                               | )          | (5,906                                              | )          | (15,101 | ) | (5,144 | ) |
| Other income, net                                      |       | 34                                                   |       | 10                                                  |       | 58 |   | 168 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Loss before income taxes                               |       | (7,470                                               | )          | (5,896                                              | )          | (15,043 | ) | (4,976 | ) |
| Income tax benefit                                     |       | —                                               |       | 474                                                 |       | — |   | 395 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss                                               |       | (7,470                                               | )          | (5,422                                              | )          | (15,043 | ) | (4,581 | ) |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss per common share:                             |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                  |       | $                                                    | (0.31      | )                                                   | $          | (0.23 | ) | $ | (0.63 | ) | $ | (0.19 | ) |
| Diluted                                                |       | $                                                    | (0.31      | )                                                   | $          | (0.23 | ) | $ | (0.63 | ) | $ | (0.19 | ) |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average number of common shares  outstanding: |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                  |       | 24,161,904                                           |       | 23,813,040                                          |       | 24,061,194 |   | 23,741,785 |   |
| Diluted                                                |       | 24,161,904                                           |       | 23,813,040                                          |       | 24,061,194 |   | 23,741,785 |   |

 

See accompanying notes.

 

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**CARDIONET, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(*In thousands*)**

 
| ** **                                                                                           | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| **Operating activities**                                                                             |       |                                                |       |   |   |
| Net loss                                                                                             |       | $                                                   | (15,043    | ) | $ | (4,581 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities:                         |       |                                                |       |   |   |
| Depreciation                                                                                         |       | 8,789                                               |       | 7,240 |   |
| Amortization of intangibles                                                                          |       | 310                                                 |       | 669 |   |
| Amortization of investment premium                                                                   |       | 255                                                 |       | — |   |
| Loss on disposal of property and equipment                                                           |       | 433                                                 |       | 184 |   |
| (Decrease) increase in deferred rent                                                                 |       | (234                                                | )          | 598 |   |
| Provision for doubtful accounts                                                                      |       | 14,058                                              |       | 14,086 |   |
| Stock-based compensation                                                                             |       | 3,058                                               |       | 5,458 |   |
| Changes in operating assets and liabilities:                                                         |       |                                                |       |   |   |
| Accounts receivable                                                                                  |       | (11,239                                             | )          | (24,048 | ) |
| Prepaid expenses and other current assets                                                            |       | (785                                                | )          | (300 | ) |
| Other assets                                                                                         |       | (194                                                | )          | 153 |   |
| Accounts payable                                                                                     |       | (1,724                                              | )          | 2,520 |   |
| Accrued and other liabilities                                                                        |       | (1,513                                              | )          | (3,756 | ) |
|                                                                                                 |       |                                                |       |   |   |
| Net cash used in operating activities                                                                |       | (3,829                                              | )          | (1,777 | ) |
|                                                                                                 |       |                                                |       |   |   |
| **Investing activities**                                                                             |       |                                                |       |   |   |
| Purchases of property and equipment                                                                  |       | (3,672                                              | )          | (16,527 | ) |
| Purchases of short-term available-for-sale  investments                                              |       | (34,684                                             | )          | — |   |
| Sale or maturity of short-term available-for-sale  investments                                       |       | 2,200                                               |       | — |   |
|                                                                                                 |       |                                                |       |   |   |
| Net cash used in investing activities                                                                |       | (36,156                                             | )          | (16,527 | ) |
|                                                                                                 |       |                                                |       |   |   |
| **Financing activities**                                                                             |       |                                                |       |   |   |
| Proceeds from the exercise of employee stock  options and employee stock purchase plan contributions |       | 1,464                                               |       | 3,078 |   |
| Repayment of debt                                                                                    |       | —                                              |       | (72 | ) |
|                                                                                                 |       |                                                |       |   |   |
| Net cash provided by financing activities                                                            |       | 1,464                                               |       | 3,006 |   |
|                                                                                                 |       |                                                |       |   |   |
| Net decrease in cash and cash equivalents                                                            |       | (38,521                                             | )          | (15,298 | ) |
| Cash and cash equivalents — beginning of period                                                 |       | 49,152                                              |       | 58,171 |   |
|                                                                                                 |       |                                                |       |   |   |
| Cash and cash equivalents — end of period                                                       |       | $                                                   | 10,631     |   | $ | 42,873 |   |
|                                                                                                 |       |                                                |       |   |   |
| **Supplemental disclosure of cash  flow information**                                                |       |                                                |       |   |   |
| Cash paid for interest                                                                               |       | $                                                   | 3          |   | $ | 10 |   |
| Cash paid for taxes                                                                                  |       | $                                                   | 675        |   | $ | 6,130 |   |

 

See accompanying notes.

 

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**CARDIONET, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**(*In thousands, except share and pershare amounts*)**

 

**1.     Summary ofSignificant Accounting Policies**

 

**Unaudited Interim Financial Data**

 

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with U.S. generally accepted accounting principles for interimfinancial information and the requirements of Form 10-Q and Article 10of Regulation S-X. Accordingly, these consolidated financial statements do notinclude all of the information and footnotes necessary for a completepresentation of financial position, results of operations and cash flows.  In the opinion of management, theseconsolidated financial statements reflect all adjustments which are of normalrecurring nature and necessary for a fair presentation ofCardioNet, Inc.’s (the “Company” or “CardioNet”) financial position as ofSeptember 30, 2010 and December 31, 2009, the results of operationsfor the three and nine months ended September 30, 2010 and 2009, and cashflows for the nine months ended September 30, 2010 and 2009.  The financial data and other informationdisclosed in these notes to the financial statements related to the three andnine months ended are unaudited. The results for the three and nine monthsended September 30, 2010 are not necessarily indicative of the results tobe expected for any future period.

 

**Net Loss**

 

TheCompany computes net loss per share in accordance with Financial AccountingStandards Board (FASB) Accounting Standards Codification (ASC) 260, *Earnings Per Share*.  The following summarizes the potentialoutstanding common stock of the Company at September 30, 2010 and 2009:

 
| ** **                                                           | ** ** | **September 30,  2010** | ** ** | **September 30,  2009** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Common stock options and restricted stock units  outstanding         |       | 2,007,414                    |       | 2,137,613                    |       |
| Common stock options and restricted stock units  available for grant |       | 1,767,896                    |       | 631,933                      |       |
| Common stock held by certain employees and unvested                  |       | —                       |       | 13,177                       |       |
| Common stock                                                         |       | 24,245,305                   |       | 23,867,765                   |       |
|                                                                 |       |                         |       |                         |       |
| Total                                                                |       | 28,020,615                   |       | 26,650,488                   |       |

 

Basicnet loss per share is computed by dividing net loss by the weighted averagenumber of common shares outstanding during the period. Diluted net loss pershare is computed by giving effect to all potential dilutive common shares,including stock options, warrants and convertible preferred stock, asapplicable.

 

The following table presents the calculation of basic and diluted netloss per share:

 
| ** **                                                                 | ** ** | **Three Months Ended********September 30,**                                | ** ** | **Nine Months Ended********September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2010**                                                                                  | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                                 | ** ** | **(in thousands, except share and per share amounts)** | ** ** |
| *Numerator:*                                                               |       |                                                                                      |       |                                                      |       |   |   |   |   |
| Net loss applicable to common stockholders                                 |       | $                                                                                         | (7,470     | )                                                         | $          | (5,422 | ) | $ | (15,043 | ) | $ | (4,581 | ) |
| *Denominator:*                                                             |       |                                                                                      |       |                                                      |       |   |   |   |   |
| Weighted average shares used in computing diluted  net loss per share |       | 24,161,904                                                                                |       | 23,813,040                                                |       | 24,061,194 |   | 23,741,785 |   |
| Basic net loss per share                                                   |       | $                                                                                         | (0.31      | )                                                         | $          | (0.23 | ) | $ | (0.63 | ) | $ | (0.19 | ) |
| Diluted net loss per share                                                 |       | $                                                                                         | (0.31      | )                                                         | $          | (0.23 | ) | $ | (0.63 | ) | $ | (0.19 | ) |
|                                                                            |            |                                                                                           |            |                                                           |            |  |  |  |  |  |  |  |  |  |

 

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**CARDIONET, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**(*In thousands, except share and pershare amounts*)**

 

Ifthe outstanding vested options or restricted stock units were exercised orconverted into common stock, the result would be anti-dilutive for the threeand nine months ended September 30, 2010 and 2009. Accordingly, basic anddiluted net loss attributable to common stockholders per share are identicalfor the three and nine months ended September 30, 2010 and 2009 and arepresented in the consolidated statements of operations.

 

**ComprehensiveLoss**

 

Comprehensive loss consists of net loss and all changes instockholders’ equity from non-stockholder sources. The following summarizes thecomponents of the Company’s comprehensive loss:

 
| ** **                    | ** ** | **Three Months Ended********September 30,** | ** ** | **Nine Months Ended********September 30,** | ** ** |
|-------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                    | ** ** | **2010**                                                   | ** ** | **2009**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
|                          |       |                                                       |       |                                                      |       |   |   |   |   |
| Net loss                      |       | $                                                          | (7,470     | )                                                         | $          | (5,422 | ) | $ | (15,043 | ) | $ | (4,581 | ) |
| Other comprehensive income:   |       |                                                       |       |                                                      |       |   |   |   |   |
| Unrealized gain on securities |       | 37                                                         |       | —                                                    |       | 18 |   | — |   |
| Total comprehensive loss      |       | (7,433                                                     | )          | (5,422                                                    | )          | (15,025 | ) | (4,581 | ) |
|                               |            |                                                            |            |                                                           |            |  |  |  |  |  |  |  |  |

 

**Cash and Cash Equivalents**

 

Cash and cashequivalents are held in U.S. financial institutions or in custodial accountswith U.S. financial institutions. Cash equivalents are defined as liquidinvestments and money market funds with maturity from date of purchase of 90days or less that are readily convertible into cash and have insignificantinterest rate risk.

 

**Available-for-Sale Investments**

 

Marketablesecurities that do not meet the definition of cash and cash equivalents areclassified as available-for-sale. Available-for-sale securities are carried atfair value, based on quoted market prices and observable inputs, withunrealized gains and losses, reported as a separate component of stockholders’equity. We classify securities as current or non-current assets on theconsolidated balance sheet based on maturity dates. The amortized cost of debtsecurities is adjusted for amortization of premiums and accretions of discountsto maturity. Amortization of debt premiums and accretion of debt discounts arerecorded in other income and expense. Realized gains and losses, and declinesin value, that are considered to be other-than-temporary, are recorded in otherincome and expense. The cost of securities sold is based on specificidentification.

 

**Accounts Receivable**

 

Receivables are recorded at the time revenue is recognized, net ofcontractual allowances. The Company makes estimates each quarter regarding thecollectability of its receivables as of the balance sheet date. The estimatestake into consideration the most recent information available to the Company,as well as cash collection trends and the aging of receivables. Receivables arepresented on the balance sheet net of allowances for doubtful accounts.Receivables are written off when the Company believes the likelihood forcollection is remote, the receivables have been fully reserved, and when theCompany believes collection efforts have been fully exhausted and it does notintend to devote additional resources in attempting to collect. Prior to thethird quarter of 2010, the Company performed an annual accounts receivablewrite-off in the fourth quarter. The Company has determined it will evaluateoutstanding receivables and perform write-offs quarterly going forward,beginning in the third quarter of 2010. The Company wrote off $22,775 ofreceivables in the third quarter of 2010. The impact was a reduction of grossreceivables and a reduction in the allowance for doubtful accounts. There wasno impact on the net receivables reported on the balance sheet as of September 30,2010 or bad debt expense reported on the statement of operations for the threeor nine months ended September 30, 2010 as a result of this write-off.

 

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**CARDIONET, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**(*In thousands, except share and pershare amounts*)**

 

**Goodwill**

 

TheCompany considers its business to be one reporting unit for the purpose ofperforming its goodwill impairment analysis. Goodwill is reviewed forimpairment annually, or when events arise that could indicate that impairmentexists. To determine whether impairment exists, the Company estimates the fairvalue of the reporting unit using an income approach, generally a discountedcash flow methodology that includes assumptions for, among other things,forecasted income, cash flow, growth rates, income tax rates, expected taxbenefits and long-term discount rates, all of which require significant judgment.The Company also considers comparable market data to assist in determining thefair value of its reporting unit. There are inherent uncertainties related tothese factors and the judgment applied in the analysis. The Company believesthat the combination of an income and a market approach provides a reasonablebasis to estimate the fair value of the reporting unit. If the estimated fairvalue of the reporting unit is less than its carrying value, impairment mayexist and additional analysis will be undertaken to determine the amount ofimpairment.

 

TheCompany experienced a decline in its stock price during the nine months endedSeptember 30, 2010. The Company considers the stock price decline to be anevent that could indicate goodwill impairment has occurred. Goodwill was testedfor impairment as of September 30, 2010. A discounted cash flow analysiswas performed, taking into consideration revenue and profit projections basedon the most recent data available to the Company. The result of the impairmenttest yielded an estimated fair market value of the reporting unit that wasgreater than the carrying value. Because the estimated fair value was in excessof the book value, the Company did not proceed to step 2 of the impairment testas described in ASC 350-20-35, *Intangibles — Goodwill andOther*.

 

**Stock-Based Compensation**

 

ASC718, *Compensation — Stock Compensation*,addresses the accounting for share-based payment transactions in which anenterprise receives employee services in exchange for (a) equity instrumentsof the enterprise or (b) liabilities that are based on the fair value ofthe enterprise’s equity instruments or that may be settled by the issuance ofsuch equity instruments. ASC 718 requires that an entity measure the cost ofequity-based service awards based on the grant-date fair value of the award andrecognize the cost of such awards over the period during which the employee isrequired to provide service in exchange for the award (the vesting period). ASC718 requires that an entity measure the cost of liability-based service awardsbased on current fair value that is re-measured subsequently at each reportingdate through the settlement date. The Company accounts for equity awards issuedto non-employees in accordance with ASC 505-50, *Equity-BasedPayments to Non-Employees*.

 

TheCompany’s income before and after income taxes for the nine months endedSeptember 30, 2010 and 2009, was reduced by $3,058 and $5,458,respectively, as a result of stock-based compensation expense incurred. Theimpact of stock-based compensation expense was $(0.13) and $(0.23) on bothbasic and diluted earnings per share for the nine months endedSeptember 30, 2010 and 2009, respectively.

 

Weestimate the fair value of our share-based awards to employees and directorsusing the Black-Scholes option valuation model. The Black-Scholes optionvaluation model requires the use of certain subjective assumptions. The mostsignificant of these assumptions are our estimates of the expected volatilityof the market price of our stock and the expected term of the award. We baseour estimates of expected volatility on a group of similar entities whose stockprices are publicly available. The expected term represents the period of timethat stock-based awards granted are expected to be outstanding. Otherassumptions used in the Black-Scholes option valuation model include therisk-free interest rate and expected dividend yield. The risk-free interestrate for periods pertaining to the contractual life of each option is based onthe U.S. Treasury yield of a similar duration in effect at the time of grant.We have never paid, and do not expect to pay, dividends in the foreseeablefuture.

 

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**CARDIONET, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**(*In thousands, except share and pershare amounts*)**

 

TheCompany utilized the Black-Scholes valuation model for estimating the fairvalue of stock options granted using the following weighted averageassumptions:

 
| ** **              | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|
| ** **              | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| Expected dividend yield |       | 0                                                   | %          | 0 | % |
| Expected volatility     |       | 65                                                  | %          | 55 | % |
| Risk-free interest rate |       | 2.37                                                | %          | 2.24 | % |
| Expected life           |       | 6.25 years                                          |       | 6.25 years |   |

 

Basedon the Company’s historical experience of options that cancel before becomingfully vested, the Company has assumed an annualized forfeiture rate of 15% forall options. Under the true-up provision of ASC 718, the Company will record additionalexpense if the actual forfeiture rate is lower than estimated, and will recorda recovery of prior expense if the actual forfeiture rate is higher thanestimated.

 

Basedon the above assumptions, the per share weighted average fair value of the optionsgranted under the stock option plan for the nine months endedSeptember 30, 2010 and 2009 was $4.16 and $10.81, respectively.

 

Thefollowing table summarizes activity under all stock award plans fromDecember 31, 2009 through September 30, 2010:

 
| ** **                             | ** ** | ** **         | ** ** | **Options Outstanding** | ** ** |
|----------------------------------------|------------|--------------------|------------|------------------------------|------------|
| ** **                             | ** ** | **Shares**         | ** ** | ** **                   | ** ** | **Weighted** | ** ** |
| ** **                             | ** ** | **Available**      | ** ** | **Number**                   | ** ** | **Average** | ** ** |
| ** **                             | ** ** | **for Grant** | ** ** | **of Shares**           | ** ** | **Exercise Price** | ** ** |
| Balance — December 31, 2009  |       | 1,132,135          |       | 1,575,645                    |       | $ | 15.21 |   |
| Additional options available for grant |       | 1,194,094          |       | —                       |       | $ | — |   |
| Granted                                |       | (10,000            | )          | 10,000                       |       | $ | 6.43 |   |
| Canceled                               |       | 134,985            |       | (134,985                     | )          | $ | 5.17 |   |
| Exercised                              |       | —             |       | (14,347                      | )          | $ | 2.99 |   |
|                                   |       |               |       |                         |       |   |   |
| Balance — March 31, 2010     |       | 2,451,214          |       | 1,436,313                    |       | $ | 15.70 |   |
|                                   |       |               |       |                         |       |   |   |
| Granted                                |       | (819,663           | )          | 819,663                      |       | $ | 7.26 |   |
| Canceled                               |       | 43,620             |       | (43,620                      | )          | $ | 14.18 |   |
| Exercised                              |       | —             |       | (90,919                      | )          | $ | 7.09 |   |
|                                   |       |               |       |                         |       |   |   |
| Balance — June 30, 2010      |       | 1,675,171          |       | 2,121,437                    |       | $ | 12.83 |   |
|                                   |       |               |       |                         |       |   |   |
| Granted                                |       | (70,000            | )          | 70,000                       |       | $ | 4.66 |   |
| Canceled                               |       | 162,725            |       | (162,725                     | )          | $ | 17.67 |   |
| Exercised                              |       | —             |       | (21,298                      | )          | $ | 7.46 |   |
|                                   |       |               |       |                         |       |   |   |
| Balance — September 30, 2010 |       | 1,767,896          |       | 2,007,414                    |       | $ | 11.89 |   |

 

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**CARDIONET, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**(*In thousands, except share and pershare amounts*)**

 

Perthe plan documents, the 2008 Non-Employee Director Stock Option (NEDS) andEmployee Stock Option (ESOP) Plans have an automatic increase in the sharesavailable for grant every January the plans are active. The increase inthe shares available for grant under the NEDS plan is equal to the lesser ofthe number of shares issuable upon the exercise of options granted during thepreceding calendar year or such number of shares as determined by the Board ofDirectors. The increase in the shares available for grant under the ESOP planis equal to 5% of the total shares outstanding at December 31, 2009.

 

Additionalinformation regarding options outstanding is as follows:

 
| ** **                                           | ** ** | **September 30,  2010** | ** ** | **September 30,  2009** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Range of exercise prices (per option)                |       | $0.70 -$31.18                |       | $0.70 - $31.18               |       |
| Weighted average remaining contractual life  (years) |       | 7.87                         |       | 8.95                         |       |

 

*EmployeeStock Purchase Plan*

 

OnMarch 17, 2010 and September 17, 2010, 83,659 and 77,440 shares,respectively, were purchased in accordance with the Employee Stock PurchasePlan (ESPP). Net proceeds to the Company from the issuance of shares of commonstock under the ESPP for the nine months ended September 30, 2010 were$798. In January 2010, the number of shares available for grant wasincreased by 239,750, per the ESPP plan documents. At September 30, 2010,approximately 381,144 shares remain available for purchase under the ESPP.

 

**New Accounting Pronouncements**

 

InJanuary 2010, the FASB issued authoritative guidance intended to improvedisclosures about fair value measurements. The guidance requires entities todisclose significant transfers in and out of fair value hierarchy levels andthe reasons for the transfers. Additionally, the guidance clarifies that areporting entity should provide fair value measurements for each class ofassets and liabilities and disclose the inputs and valuation techniques usedfor fair value measurements using significant other observable inputs (Level 2)and significant unobservable inputs (Level 3). Level 3 reconciliations shouldpresent separately information about purchases, sales, issuances andsettlements. To date, the Company has not had any assets or liabilities thattransferred in or out of fair value hierarchy levels, and as such, is notcurrently subject to this guidance. This guidance is effective for interim andannual periods beginning after December 15, 2009, except for thedisclosures about purchases, sales, issuances and settlements in the Level 3reconciliations, which is effective for fiscal years beginning after December 15,2010. This guidance did not have an impact on the Company’s results ofoperations or financial position. The Company adopted this guidance effectiveDecember 31, 2009. The Company believes the enhanced Level 3 disclosureswill not have an impact on the Company’s results of operations or financialposition.

 

InFebruary 2010, the FASB issued authoritative guidance on subsequentevents. The guidance requires an SEC filer to evaluate subsequent eventsthrough the date the financial statements are issued but no longer requires anSEC filer to disclose the date through which the subsequent event evaluationoccurred. The guidance became effective for the Company upon issuance and hadno impact on the Company’s results of operations or financial position.

 

**2.             Available-for-SaleInvestments**

 

Weinvest our excess funds in securities issued by the United States government,corporations, banks, municipalities, financial holding companies and in moneymarket funds comprised of these same types of securities. Our cash and cashequivalents and available-for-sale investments are placed with high creditquality financial institutions. Additionally, we diversify our investmentportfolio in order to maintain safety and liquidity. We do not holdmortgage-backed securities. As of September 30, 2010, all of ourinvestments will mature within one year. These investments are recorded at fairvalue, based on quoted market prices, with unrealized gains and losses reportedas a separate component of stockholders’ equity.

 

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**CARDIONET, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**(*In thousands, except share and pershare amounts*)**

 

Investmentshave been classified as available-for-sale investments. At September 30,2010, available-for-sale investments are detailed as follows:

 
| ** **                               | ** ** | **Amortized** | ** ** | **Gross Unrealized** | ** ** | **Gross Unrealized** | ** ** | **Estimated**       | ** ** |
|------------------------------------------|------------|---------------|------------|---------------------------|------------|---------------------------|------------|---------------------|------------|
| ** **                               | ** ** | **Cost**      | ** ** | **Gains**                 | ** ** | **Losses**                | ** ** | **Fair Value** | ** ** |
| Short-term investments:                  |       |          |       |                      |       |                      |       |                |       |
| Corporate debt securities                |       | $             | 13,297     |                      | $          | 6                         |       | $                   | (4         | ) | $ | 13,299 |   |
| U.S. Treasury and agency debt securities |       | 18,932        |       | 16                        |       | —                    |       | 18,948              |       |
|                                     |       | $             | 32,229     |                      | $          | 22                        |       | $                   | (4         | ) | $ | 32,247 |   |

 

Netunrealized gains on available-for-sale investments are included as a componentof stockholders’ equity and comprehensive loss until realized from a sale orother-than-temporary impairment. The Company recorded net unrealized gains forthe nine months ended September 30, 2010 and 2009 of $18 and $0,respectively. Realized gains and losses from the sale of securities aredetermined on a specific identification basis. Purchases and sales ofinvestments are recorded on their trade dates. Dividend and interest income arerecognized when earned. Interest income for the nine months endedSeptember 30, 2010 was $310, which was partially offset by $255 related toamortization of investment premiums.

 

Maturitiesof available-for-sale investments were as follows at September 30, 2010:

 
| ** **                             | ** ** | **Amortized  Cost** | ** ** | **Estimated  Fair Value** | ** ** |
|----------------------------------------|------------|---------------------|------------|--------------------------------|------------|
|                                   |       |                |       |                           |       |
| Due within one year                    |       | $                   | 32,229     |                           | $          | 32,247 |   |
| Due after one year through five years  |       | —              |       | —                         |       |
| Due after five years through ten years |       | —              |       | —                         |       |
| Due after ten years                    |       | —              |       | —                         |       |
|                                   |       |                |       |                           |       |
|                                   |       | $                   | 32,229     |                           | $          | 32,247 |   |

 

**3.             FairValue Measurements**

 

ASC820 defines fair value as an exit price that would be received from the sale ofan asset or paid to transfer a liability in the principal or most advantageousmarket for the asset or liability in an orderly transaction between marketparticipants on the measurement date. ASC 820 establishes a three-level hierarchyfor disclosure that is based on the extent and level of judgment used toestimate the fair value of assets and liabilities.

 
| · | Level  1 — Valuations based on quoted prices for identical assets or liabilities in  active markets at the measurement date. Since valuations are based on quoted  prices that are readily and regularly available in an active market,  valuation of these products does not entail a significant degree of judgment.  Our Level 1 assets consist of cash and money market funds, as well as U.S.  Treasury and agency debt securities.                                                                               |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| · | Level  2 — Valuations based on quoted prices for similar assets and liabilities in  active markets; quoted prices for identical or similar assets and liabilities  in markets that are not active; or other inputs that are observable or can be  corroborated by observable market data, such as alternative pricing sources  with reasonable levels of price transparency. Our Level 2 assets consist of  fixed income securities such as corporate debt securities including  commercial paper and corporate bonds. |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| · | Level  3 — Valuations based on inputs that are unobservable and significant to the  overall fair value measurement. We have not measured the fair value of any of  our assets using Level 3 inputs.                                                                                                                                                                                                                                                                                                                    |

 

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**CARDIONET, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**(*In thousands, except share and pershare amounts*)**

 

InJanuary 2010, the FASB updated the disclosure requirements for fair valuemeasurements. The updated guidance requires companies to disclose separatelythe investments that transfer in and out of Levels 1 and 2 and the reason forthose transfers. Additionally, in the reconciliation for fair value measurementsusing significant unobservable inputs (Level 3), companies should presentseparately information about purchases, sales, issuances and settlements.During the nine months ended September 30, 2010, no transfers were madeinto or out of the different category levels, nor did the Company categorizeany of its investments as Level 3. We will continue to review our fair valueinputs on a quarterly basis. The updated guidance is effective for thereporting periods beginning after December 15, 2009, except for thedisclosures about purchases, sales, issuances and settlements in the Level 3reconciliations, which is effective for fiscal years beginning afterDecember 15, 2010. The Company will provide the additional disclosuresnecessary beginning in the Company’s fiscal year 2010 Annual Report onForm 10-K.

 

Thefair value of our financial assets subject to the disclosure requirements ofASC 820 was determined using the following levels of inputs atSeptember 30, 2010:

 

**Fair Value Measurements at September 30, 2010**

 
| ** **                               | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|-----------|------------|
| Assets:                                  |       |             |       |             |       |             |       |      |       |
| Cash                                     |       | $                | 4,999      |             | $          | —           |       | $         | —     |   | $ | 4,999 |   |
| Money market funds                       |       | 5,133            |       | —           |       | —           |       | 5,133     |       |
| Corporate debt securities                |       | —           |       | 13,798           |       | —           |       | 13,798    |       |
| U.S. Treasury and agency debt securities |       | 18,948           |       | —           |       | —           |       | 18,948    |       |
|                                     |       |             |       |             |       |             |       |      |       |
|                                     |       | $                | 29,080     |             | $          | 13,798           |       | $         | —     |   | $ | 42,878 |   |

 

**4.             Integration,Restructuring and Other Charges**

 

*2010 Restructuring*

 

During the first quarter of 2010, the Company undertook an initiativeto streamline its sales and service organizations and reduce support costscompany-wide. It also initiated plans to close its event monitoring facility inGeorgia and consolidate it with the Company’s monitoring facilities inPennsylvania and Minnesota. The Company believes that it can realize costefficiencies by undertaking these initiatives.

 

The restructuring plan involves the elimination of approximately100 positions. The restructuring activities were substantially complete bythe end of the third quarter of 2010. The Company expects the total cost of therestructuring to be approximately $4,000, all of which is expected to result incash charges. The Company incurred restructuring expenses of $2,988 for thenine months ended September 30, 2010.

 

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**CARDIONET, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**(*In thousands, except share and pershare amounts*)**

 

A summary of the reserve activity related to the 2010 restructuringplan as of September 30, 2010 is as follows:

 
| ** **                             | ** ** | **Severance and  employee  related costs** | ** ** | **Other exit  activity costs** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------|------------|-----------|------------|
| Initial reserve recorded               |       | $                                                    | 1,400      |                                     | $          | 262       |       | $ | 1,662 |   |
| Payments                               |       | (466                                                 | )          | (262                                     | )          | (728      | )          |
|                                   |       |                                                 |       |                                     |       |      |       |
| Balance — March 31, 2010     |       | 934                                                  |       | —                                   |       | 934       |       |
|                                   |       |                                                 |       |                                     |       |      |       |
| Additional reserve recorded            |       | 559                                                  |       | 342                                      |       | 901       |       |
| Payments                               |       | (360                                                 | )          | (342                                     | )          | (702      | )          |
|                                   |       |                                                 |       |                                     |       |      |       |
| Balance — June 30, 2010      |       | 1,133                                                |       | —                                   |       | 1,133     |       |
|                                   |       |                                                 |       |                                     |       |      |       |
| Additional reserve recorded            |       | 296                                                  |       | 129                                      |       | 425       |       |
| Payments                               |       | (704                                                 | )          | (129                                     | )          | (833      | )          |
|                                   |       |                                                 |       |                                     |       |      |       |
| Balance — September 30, 2010 |       | $                                                    | 725        |                                     | $          | —    |       | $ | 725 |   |

 

Integration,restructuring and other charges for the nine months ended September 30,2009 was $3,109, which was comprised primarily of severance expenses related tothe departure of certain executive officers in the first quarter of 2009 andthe 2009 restructuring plan activities that were initiated in the third quarterof 2009. The 2009 restructuring plan included the consolidation and closure ofthe Company’s event monitoring facility in Florida with its event monitoringfacility in Georgia, the shift of the majority of the Company’s manufacturingactivities to its Chester, Pennsylvania facility, and an overall reduction ofsupport costs Company-wide.

 

The Company accounts for expenses associated with exit or disposalactivities in accordance with ASC 420, *Exit or Disposal**Cost Obligations,* and records theexpenses in *Integration, restructuring and other charges*in its statement of operations, and records the related accrual in the *Accrued liabilities* line of its balance sheet.

 

*Other Charges*

 

The Company incurred other charges of $944 for the nine months endedSeptember 30, 2010, including legal costs related to the Company’s defenseof class-action and Biotel lawsuits. Additional information regarding legalproceedings can be found in Note 7.

 

**5.**              **IncomeTaxes**

 

Theincome tax provision for interim periods is determined using an estimatedannual effective tax rate adjusted for discrete items, if any, which are takeninto account in the quarterly period in which they occur. The Company reviewsand updates its estimated annual effective tax rate each quarter. For the ninemonths ended September 30, 2010, the Company’s estimated annual effectivetax rate was primarily impacted by a financial loss for the period, the benefitof which was offset by a valuation allowance. Accordingly, the Company recordedno tax expense or benefit for the nine months ended September 30, 2010.The income tax benefit totaled approximately $395 for the nine months endedSeptember 30, 2009.

 

Asof December 31, 2009, in accordance with ASC 740, the Company maintained afull valuation allowance against net deferred tax assets. The Company maintainsa full valuation allowance for the nine months ended September 30, 2010.The Company implemented the provisions of ASC 740-10 on January 1, 2007related to accounting for uncertainty in income taxes. There has been nomaterial change to the amount of unrecognized tax expense or benefit reportedas of September 30, 2010.

 

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**CARDIONET, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**(*In thousands, except share and pershare amounts*)**

 

**6.**     **Reimbursement**

 

Areduction in the Medicare reimbursement rate for our MCOTTM services to $754 perservice, a reduction of approximately 33%, went into effect onSeptember 1, 2009. The reduction in reimbursement rates has a directimpact in the reduction of revenue for the nine months ended September 30,2010.

 

Duringthe third quarter of 2010, the local entity responsible for Medicare carrierpricing, Highmark Medicare Services (“Highmark”), conducted a prepayment reviewof the Company’s Medicare claims. This review involved an evaluation of medicalrecords and application of clinical judgment by Highmark about whether aservice is covered, and is reasonable and necessary. As a result of thisreview, reimbursement payments to the Company were temporarily suspended in thethird quarter of 2010 and caused an estimated reduction in cash collections of$7,000 to $9,000. Effective October 25, 2010, Highmark completed the prepaymentreview and the Company anticipates cash collections will resume for itsMedicare claims in November 2010. During the period of temporaryreimbursement suspension, revenue and its related accounts receivable wererecognized as services were provided, consistent with the Company’s revenuerecognition policy.

 

**7.**     **Legal Proceedings**

 

OnMarch 5, 2010, West Palm Beach Police Pension Fund filed a putative classaction complaint in California Superior Court, San Diego County assertingclaims for violations of Sections 11, 12 and 15 of the Securities Act of 1933,as amended, against CardioNet, nine current and former officers and directorsof CardioNet and six underwriters of CardioNet’s IPO and/or Secondary Offeringon August 6, 2008 (together with the IPO, the “Offerings”). Thecomplaint filed March 5, 2010 also asserted claims for alleged violationsof Sections 25401 and 25501 of the California Corporations Code againstdefendants James M. Sweeney and Fred Middleton. The plaintiff seeks to bringclaims on behalf of all those who purchased or otherwise acquired the commonstock of CardioNet pursuant and/or traceable to the Offerings. OnMarch 10, 2010, plaintiff filed an Amended Complaint that deleted theclaims for violations of the California Corporations Code.  The claims arebased on purported misrepresentations and omissions in the RegistrationStatements for the Offerings relating to alleged business decisions made byCardioNet that were supposedly not disclosed to investors and alleged misstatementsconcerning CardioNet’s business.  On April 5, 2010, all defendantsremoved the case to the Southern District of California, where it ispending.  On April 7, 2010, defendants filed a Motion to Transfer thecase to the Eastern District of Pennsylvania. On April 23, 2010, theplaintiff moved to remand the case to state court. On May 19, 2010, thecourt ordered that defendants’ response to the complaint will be due 21 daysafter the order on the Motion to Remand. On May 28, 2010, defendants filedtheir opposition to the Motion to Remand, and plaintiff filed its opposition tothe Motion to Transfer. On June 14, 2010, plaintiff filed its reply insupport of the Motion to Remand, and on June 18, 2010, defendants’ replyin support of the Motion to Transfer was filed. On June 21, 2010, thecourt found the motions suitable for disposition on the written motionssubmitted by the parties without oral argument.  The Company believes thatthe claims are without merit and intends to defend the litigation vigorously.At this time, it is not possible to determine the likelihood or amount ofliability, if any, on the part of the Company with any degree of certainty.Consistent with the accounting for contingent liabilities, no accrual has beenrecorded in the financial statements.

 

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**CARDIONET, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**(*In thousands, except share and per shareamounts*)**

 

Commencingon August 26, 2009, two putative class actions were filed in the UnitedStates District Court for the Eastern District of Pennsylvania namingCardioNet, Randy Thurman, former Chief Executive Officer and Martin P. Galvan,former Chief Financial Officer as defendants and alleging violations ofSections 10(b) and 20(a) of the Securities Exchange Act of 1934, asamended.  The complaints purport to bringclaims on behalf of a class of persons who purchased the Company’s common stockbetween April 30, 2009 and June 30, 2009 and between April 30,2009 and July 10, 2009.  Thecomplaints allege that the defendants issued various materially false andmisleading statements relating to the Company’s projected performance that hadthe effect of artificially inflating the market price of its securities.  The complaints further allege that thealleged misstatements were revealed to the public on June 30, 2009 andJuly 10, 2009 when the Company made certain announcements regardingpotential lower pricing for commercial and Medicare reimbursement rates.  These actions were consolidated onSeptember 9, 2009.  OnOctober 26, 2009, two competing motions were filed for appointment of leadplaintiffs and lead counsel pursuant to the requirements of the PrivateSecurities Litigation Reform Act of 1995.  On December 22, 2009, the Court appointed lead plaintiff, butdenied its request for appointment of lead counsel and required lead plaintiffto file an amended motion for approval of its selection of class counsel. Leadplaintiff filed its amended motion for appointment of lead counsel onJanuary 15, 2010, which was granted on February 3, 2010. Leadplaintiff filed a consolidated class action complaint on February 19, 2010and the defendants filed a motion to dismiss on March 26, 2010. Leadplaintiff filed its opposition to the motion to dismiss on April 30, 2010.On May 13, 2010, defendants moved for leave to file a reply brief, whichmotion was granted and the reply brief was filed May 20, 2010. On August 10,2010, the Court issued an opinion dismissing the consolidated class actioncomplaint. Plaintiffs have not appealed that decision which became final onSeptember 9, 2010.

 

OnApril 2, 2009 CardioNet entered into a Merger Agreement to acquire (“Biotel”)Inc. for $14,000. On July 14, 2009, CardioNet exercised its contractual rightto terminate the Merger Agreement due to Biotel’s breach of certain covenantsin the agreement. On or about July 16, 2009, Biotel subsequently commencedlitigation against CardioNet in Minnesota District Count in Hennepin County,Fourth Judicial District, alleging that CardioNet had breached and improperlyterminated the Merger Agreement. CardioNet removed the action to the UnitedStates District Court for the District of Minnesota on the basis of diversityjurisdiction, and Biotel did not seek to remand the action. Biotel is seeking specificperformance and damages in an amount in excess of $10,000. CardioNet hascounterclaimed under the terms of the Merger Agreement for its termination feeand associated expenses; the current amount of that counterclaim is $1,400.Discovery has been concluded and the case has been set for a two-week trialstarting January 11, 2011. Biotel has brought a motion for partial summaryjudgment directed to certain CardioNet defenses and the counterclaim; the Courthas held a hearing on that motion and has taken the motion under advisement.The Company has defended, and continues to defend, its position vigorously. The2010 Merger Agreement (as defined in Note 8 below) includes a SettlementAgreement that will resolve the CardioNet-Biotel litigation and result in amutual release of all claims arising out of, in connection with, or related tothe April 2, 2009 Merger Agreement, including the claims in the litigation, butonly if the merger contemplated by the 2010 Merger Agreement is closed or ifcertain other conditions occur or are satisfied. The mutual release set forthin the Settlement Agreement does not go into effect unless and until the 2010Merger Agreement is closed or the other conditions occur or are satisfied. As apart of the Settlement Agreement, the parties have agreed to move the DistrictCourt to stay the litigation. If the mutual releases in the SettlementAgreement do not go into effect, CardioNet will continue to defend its positionand will continue to prosecute its counterclaim. At this time, it is notpossible to determine, if the case should go forward to trial, the likelihoodor amount of liability, if any, on the part of the Company with any degree ofcertainty. Consistent with the accounting for contingent liabilities, noaccrual has been recorded in the financial statements.

 

**8.**     **Subsequent Events**

 

On November 2, 2010, CMS published The Medicare Program Final Rule establishinga national rate for the MCOTTM technology (CPT Code 93229). CMS valued the CPTcode at 20.14 relative value units. Using the formula and values currently inplace, the Company estimates the national rate to be approximately $800 perservice, effective January 1, 2011. This is an increase of approximately6% from the current local carrier rate of $754 per service that was previouslyestablished by Highmark. The values incorporated in the current formula willexpire in December 2010. If the United States Congress (“Congress”) doesnot act before December 31, 2010 to continue the values, then all paymentsunder the physician fee schedule will be reduced by approximately 25%.Historically, Congress has taken action to prevent the scheduled reduction andwe anticipate Congress will do so again in December 2010. However, ifCongress does not take action to postpone the rate reduction the rate will beapproximately $560.

 

On November 5, 2010, the Company entered into a Merger Agreement(the “2010 Merger Agreement”) with Biotel Inc., a Minnesota corporation(referred to herein as “Biotel”). Upon the closing date of the transaction,which is expected to be on or around December 20, 2010, the Company willacquire all of the outstanding capital stock of Biotel for approximately$11,000, subject to adjustment for the amount of working capital of Biotel asof the closing date of the transaction. The 2010 Merger Agreement effectivelyterminates the Merger Agreement with Biotel that was dated April 2, 2009.The merger will provide the Company with additional development, manufacturingand testing capabilities related to its event monitor product line. Inconnection with entering into the 2010 Merger Agreement, the Company enteredinto a Settlement Agreement with Biotel, pursuant to which, among other things,the litigation between the parties will be terminated at the time of closingunder the Merger Agreement.

 

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**Item 2. Management’s Discussion and Analysis of Financial Condition andResults of Operations.**

 

The following discussion and analysis should be readin conjunction with our Annual Report on Form 10-K for the year endedDecember 31, 2009, and in conjunction with the accompanying quarterlyunaudited condensed consolidated financial statements. This discussion containscertain forward-looking statements that involve risks and uncertainties. TheCompany’s actual results and the timing of certain events could differmaterially from those discussed in these forward-looking statements as a resultof certain factors, including, but not limited to, those set forth herein andelsewhere in this report and in the Company’s other filings with the Securitiesand Exchange Commission. See the “Forward-Looking Statements” section at thebeginning of this report.

 

**Company Background**

 

CardioNet is a leading provider of ambulatory, continuous, real-timeoutpatient management solutions for monitoring relevant and timely clinicalinformation regarding an individual’s health. The Company’s efforts haveinitially been focused on the diagnosis and monitoring of cardiac arrhythmias,or heart rhythm disorders, with a solution that it markets as Mobile CardiacOutpatient TelemetryTM (MCOTTM). The Company actively began developing itsproduct platform in April 2000, and since that time, has devotedsubstantial resources in advancing its patient monitoring solutions. Theplatform successfully integrates a wireless data transmission network,internally developed software, FDA-cleared algorithms and medical devices, anda 24-hour monitoring service center.

 

The Company’s Conshohocken location has been an approved IndependentDiagnostic Testing Facility (“IDTF”) by Medicare since it received510(k) clearance for the first and second generation of its core MCOTdevices in 2002. The CardioNet Monitoring Center commenced operations inConshohocken, Pennsylvania in 2002, concurrent with its first FDA approval, andall of the Company’s MCOT arrhythmia monitoring activities are currentlyconducted at that location. The Company received FDA 510(k) clearance forthe proprietary algorithm included in its third generation product, or C3, inOctober 2005. Subsequently in November 2006, the Company received FDA510(k) clearance for its C3 system which it has incorporated as part ofits monitoring solution. The Company received FDA 510(k) clearance for itsnext generation platform in April 2010 and expects the product launch tooccur in early 2011. The Company continues to pursue innovation of new andexisting medical solutions through investments in research and development.

 

InMarch 2007, the Company acquired all of the outstanding capital stock ofPDSHeart. The acquisition of PDSHeart provided three additional product linesto complement MCOTTM: event, Holter and Pacemaker monitoring solutions. Inaddition, the acquisition supplied the Company with existing sales channels andrelationships in geographic areas that previously had not been penetrated priorto the acquisition. In March 2008, the Company completed an initial publicoffering of its common stock for proceeds of approximately $46.7 million,net of underwriter commissions and estimated offering expenses.

 

**Reimbursement**

 

The reimbursement rates applicable to the Category I CPT codes (93228and 93229) established by the American Medical Association (“AMA”) for MCOTTMbecame effective on January 1, 2009. Highmark Medicare Services(“Highmark”) is responsible for setting the reimbursement rate on behalf of CMSfor code 93229, which is the code for the technical component of our services.The new billing codes allow for automated claims adjudication, substantiallysimplifying the reimbursement process for physicians and payors compared to theprevious process. Reimbursement prior to the use of the new CPT codes was obtainedthrough non-specific billing codes which required various narratives that, inmost cases, involved semi-automated or manual processing, as well as additionalreview by payors.

 

After receiving the CPT code in the first quarter of 2009, the Companyreceived pressure from several commercial payors to renegotiate reimbursementrate contracts. This pressure led to a substantial decline in our averagecommercial reimbursement rates in the first half of 2009. During the secondhalf of 2009, and throughout the first half of 2010, we have seen commercialreimbursement rates stabilize. The Company experienced a decline in commercialreimbursement rates during the third quarter of 2010. During 2010 and 2009, theCompany’s commercial reimbursement rates declined approximately 15% and 17%,respectively. The Company expects to experience fluctuations in its averagecommercial reimbursement rates due to payor mix, as well as contract negotiationsfor new and existing payors. Overall, we expect the average commercialreimbursement rates to remain stable or decline over time.

 

On July 10, 2009,Highmark announced a reduction in the Medicare reimbursement rate for our MCOTTMservices to $754 per service, a reduction of approximately 33%. This new ratewent into effect on September 1, 2009. The decline in reimbursement ratehas had a negative impact on the Company’s revenue and operating results, andhas presented significant challenges to the viability of the Company’s currentbusiness model. The Company estimates that the rate reduction caused areduction in revenue for the four months ended December 31, 2009 and thenine months ended September 30, 2010, of approximately $6.3 million and$14.2 million, respectively. Several strategic initiatives are currently beingimplemented, including cost reduction initiatives, process improvement andfacility consolidation in an effort to improve the Company’s operatingperformance given the reduced reimbursement rate.

 

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On November 2, 2010, CMS published The Medicare Program Final Rule establishinga national rate for the MCOTTM technology (CPT Code 93229). CMS valued the CPTcode at 20.14 relative value units. Using the formula and values currently inplace, the Company estimates the national rate to be approximately $800 perservice, effective January 1, 2011. This is an increase of approximately6% from the current local carrier rate of $754 per service that was previouslyestablished by Highmark. The values incorporated in the current formula willexpire in December 2010. If the United States Congress (“Congress”) doesnot act before December 31, 2010 to continue the values, then all paymentsunder the physician fee schedule will be reduced by approximately 25%.Historically, Congress has taken action to prevent the scheduled reduction andwe anticipate Congress will do so again in December 2010. However, ifCongress does not take action to postpone the rate reduction the rate will beapproximately $560. If no action is taken by Congress and the reimbursementrate for the Company’s MCOTTM technology is reduced to a level lower thananticipated, the rate would have a negative impact on the Company’s results ofoperations.

 

We have successfully secured contracts with many national and regionalcommercial payors. As of September 30, 2010, we have 285 MCOTTM contractswith commercial payors, compared to 245 at December 31, 2009. The currentestimated total of over 200 million covered lives for Medicare and commerciallives for which we had reimbursement contracts as of September 30, 2010represents approximately 79% of the total covered lives in the United States.The MCOTTM contracts also cover event, Holter and Pacemaker service pricing. Inaddition, as of September 30, 2010 there were approximately 165 contractswith commercial payors that pertained only to event, Holter and Pacemakerservice pricing, and did not cover MCOTTM. The majority of the remaining coveredlives are insured by a small number of large commercial insurance companiesthat deemed MCOTTM to be experimental in nature and do not currently reimburseus for services provided to their beneficiaries.

 

**Accounts Receivable**

 

Receivables are recorded at the time revenue is recognized, net ofcontractual allowances and are presented on the balance sheet net of allowancefor doubtful accounts. The Company performs analyses to evaluate the netrealizable value of accounts receivable as of the balance sheet date.Specifically, the Company considers historical realization data, accountsreceivable aging trends, other operating trends and relevant businessconditions. Because of continuing changes in the health care industry and thirdparty reimbursement, it is possible that our estimates could change, whichcould have a material impact on our operations and cash flows.

 

The Company realized improvements in its billing procedures and cashcollections activity during 2010 and experienced a corresponding decline in itsdays sales outstanding. The Company believes that it can realize additionalimprovement in its billing and collection processes, and has engaged a thirdparty consultant that is a specialist with significant experience in medicalclaims reimbursement to assist. The first phase of the project will include areview of all outstanding receivables. The Company cannot reasonably determineas of the balance sheet date what impact, if any, this review will have on thefinancial statements. This review is expected to be completed in the fourthquarter of 2010. The second phase of the project, expected to be completed inthe first half of 2011, will include a review and recommendation for changes,if needed, in the Company’s patient intake, billing and reimbursement practicesand processes.

 

During the third quarter of 2010, Highmark Medical Services conducted aprepayment review of the Company’s Medicare claims. This review involved anevaluation of medical records and application of clinical judgment by Highmarkabout whether a service is covered, and is reasonable and necessary. As aresult of this review, reimbursement payments to the Company were temporarilysuspended in the third quarter of 2010 and caused an estimated reduction incash collections of $7.0 million to $9.0 million. Effective October 25,2010, Highmark completed the prepayment review and the Company anticipates cashcollections will resume for its Medicare claims in November 2010.

 

The ultimate collection of accounts receivable may not be known forseveral months after services have been provided and billed. The Companyrecords bad debt expense based on the aging of the receivable using historicalCompany-specific data. The percentages and amounts used to record bad debtexpense and the allowance for doubtful accounts are supported by variousmethods and analyses, including current and historical cash collections, andbad debt write-offs. The Company will write-off receivables when the likelihoodfor collection is remote, the receivables have been fully reserved, and whenthe Company believes collection efforts have been fully exhausted and it doesnot intend to devote additional resources in attempting to collect. Prior tothe third quarter of 2010, the Company performed an annual accounts receivablewrite-off in the fourth quarter. The Company has determined it will evaluateoutstanding receivables and perform write-offs quarterly going forward,beginning in the third quarter of 2010. The Company wrote off $22.8 million ofreceivables in the third quarter of 2010. The impact was a reduction of grossreceivables and a reduction in the allowance for doubtful accounts. There wasno impact on the net receivables reported on the balance sheet as of September 30,2010 or bad debt expense reported on the statement of operations for the threeor nine months ended September 30, 2010 as a result of this write-off.

 

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**Medical Industry Trends**

 

Based on recent business journal articles, several trends have emergedin the medical services industry during 2010. Physicians, clinics and hospitalshave experienced a lower level of patient visits, and performed fewer electiveprocedures. The downward trend in census is being attributed to weak economicconditions, as well as changes in insurance coverage. Patients are delayingdoctor visits and deferring elective medical treatments that are not perceivedto be critical to patients’ immediate health.  In addition to otherfactors, the Company believes this overall economic trend has impacted itsvolume, leading to two consecutive quarters of modest sequential volumedeclines.

 

**Restructuring Activities**

 

During the first quarter of 2010, the Company undertook an initiativeto streamline its sales and service organizations and reduce support costsCompany-wide. It also initiated plans to close its event monitoring facility inGeorgia and consolidate it with the Company’s monitoring facilities inPennsylvania and Minnesota. The Company believes that it can realize costefficiencies by undertaking these initiatives. The total cost of therestructuring plan is expected to be approximately $4.0 million, of which $3.0million has been incurred to date. The activities were substantially completeby the end of the third quarter of 2010.

 

**nPhase Supplier Agreement**

 

The Company established a relationship with nPhase, formerlyQualcomm Inc., in May 2003. nPhase is the sole provider of wirelesscellular data connectivity solutions and data hosting and queuing services forthe Company’s monitoring network. The Company has no fixed or minimum financialcommitment as it relates to network usage or volume activity. However, if theCompany fails to maintain an agreed-upon number of active cardiac monitoringdevices on the nPhase network or it utilizes the monitoring and communicationsservices of a provider other than nPhase, nPhase has the right to terminate itsrelationship with the Company.

 

**Results of Operations**

 

***Three Months EndedSeptember 30, 2010 and 2009***

 

*Revenues.*    Totalrevenues for the three months ended September 30, 2010 decreased to $27.5million from $33.3 million for the three months ended September 30, 2009,a decrease of $5.8 million, or 17.6%. MCOTTM revenue declined $5.0 millionsubstantially due to a decrease in MCOTTM reimbursement rates. Additionally,there was a decrease in event, Holter and other revenue of $0.8 million for thethree months ended September 30, 2010 compared to the three months endedSeptember 30, 2009.

 

*Gross Profit.*    Grossprofit decreased to $15.5 million for the three months ended September 30,2010 from $21.5 million for the three months ended September 30, 2009. Thedecrease of $6.0 million was due to a decrease in revenue related to lowerMCOTTM reimbursement rates totaling $4.7 million. The remaining $1.3 millionreduction resulted largely from lower Event and Holter volume, partially offsetby lower cost of sales resulting from our Company-wide cost reductioninitiatives for the three months ended September 30, 2010 compared to thethree months ended September 30, 2009. Gross profit as a percentage ofrevenue declined to 56.6% for the three months ended September 30, 2010compared to 64.5% for the three months ended September 30, 2009.

 

*General and Administrative Expense.*    Generaland administrative expense was $8.7 million for the three months endedSeptember 30, 2010 compared to $9.7 million for the three months endedSeptember 30, 2009. The decrease of $1.0 million, or 10.5%, was dueprimarily to our restructuring efforts resulting in a decrease in professionalfees of $0.7 million, payroll costs of $0.5 million, and stock compensationexpense of $0.3 million. The decrease was offset by an increase in consultingcosts of $0.2 million, depreciation expense of $0.2 million and other costs of$0.1 million. As a percent of total revenues, general and administrativeexpense was 31.7% for the three months ended September 30, 2010 comparedto 29.2% for the three months ended September 30, 2009.

 

*Sales and Marketing Expense.*    Salesand marketing expense was $7.3 million for the three months endedSeptember 30, 2010 compared to $9.6 million for the three monthsended September 30, 2009. The decrease of $2.3 million, or 23.6%, was dueto lower payroll, travel and stock based compensation costs primarily resultingfrom Company-wide cost reduction efforts in 2010. As a percent of totalrevenues, sales and marketing expense was 26.6% for the three months endedSeptember 30, 2010 compared to 28.7% for the three months endedSeptember 30, 2009.

 

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*Bad Debt Expense.*    Baddebt expense was $4.9 million for the three months ended September 30,2010 compared to $5.6 million for the three months ended September 30,2009. The decrease of $0.7 million, or 12.5%, was due to lower gross receivablebalances moving into older aging brackets with higher reserve percentages,which was a result of improved cash collections in 2010. The bad debt expensewe recorded was based upon an evaluation of our historical collectionexperience of accounts receivable, by age, for our various payor classes.Highmark’s prepayment review had a minimal impact on the bad debt expense forthe three months ended September 30, 2010.

 

*Research and Development Expense.*    Researchand development expense was $1.2 million for the three months endedSeptember 30, 2010 compared to $1.3 million for the three months endedSeptember 30, 2009. The decrease of $0.1 million, or 6.6%, was largely dueto lower payroll costs. As a percent of total revenues, research anddevelopment expense was 4.5% for the three months ended September 30, 2010compared to 4.0% for the three months ended September 30, 2009.

 

*Integration, Restructuring and Other Charges.*    TheCompany incurred restructuring costs of $0.4 million and other charges of $0.5million for the three months ended September 30, 2010. The restructuringcosts included $0.3 million of severance and employee related costs and $0.1million of other charges related to the 2010 restructuring plan. The 2010restructuring plan included the consolidation of the Company’s sales andservice organizations, the closure of the Company’s event monitoring facilityin Georgia and consolidation of its monitoring facilities in Pennsylvania andMinnesota, and an overall reduction of administrative costs Company-wide.Integration, restructuring and other charges were 3.1% of total revenues forthe three months ended September 30, 2010. The other charges related tolegal costs and other miscellaneous items.

 

TheCompany incurred severance charges related to executive employee terminationsof $1.2 million for the three months ended September 30, 2009.

 

*Income Taxes.*    TheCompany received no tax benefit for the three months ended September 30,2010, compared to a tax benefit of $0.5 million for the three months endedSeptember 30, 2009. The effective tax rate for the three months endedSeptember 30, 2010 was 0.0%, compared to 8.0% for the three months endedSeptember 30, 2009. The effective tax rate is 0.0% because the Company isin a net operating loss position and as a result, has included the netoperating losses in its deferred tax assets balance on the balance sheet as ofSeptember 30, 2010. The Company is uncertain as to when it may realize thebenefit of its deferred tax assets, and maintains a full valuation allowance.

 

*Net Loss.*    TheCompany incurred a net loss of $7.5 million for the three months endedSeptember 30, 2010 compared to a net loss of $5.4 million for the threemonths ended September 30, 2009.

 

***Nine Months Ended September 30,2010 and 2009***

 

*Revenues.*    Totalrevenues for the nine months ended September 30, 2010 decreased to $91.2million from $107.3 million for the nine months ended September 30, 2009,a decrease of $16.1 million, or 15.0%. MCOTTM revenue decreased $13.8 milliondue to a decrease in MCOTTM reimbursement rates totaling $24.0 million. Thedecrease in reimbursement rates was offset by an increase in volume of 11%, or$7.9 million. Additionally, there was a decrease in event, Holter and otherrevenue of $2.3 million for the nine months ended September 30, 2010compared to the nine months ended September 30, 2009, due primarily tovolume declines.

 

*Gross Profit.*    Grossprofit decreased to $55.7 million for the nine months ended September 30,2010 from $71.7 million for the nine months ended September 30, 2009. Thedecrease of $16.0 million was due to a decrease in revenue offset by $2.9million of lower cost of sales resulting from our Company-wide cost initiativesfor the nine months ended September 30, 2010 compared to the nine monthsended September 30, 2009. Gross profit as a percentage of revenue declinedto 61.1% for the nine months ended September 30, 2010 compared to 66.8% forthe nine months ended September 30, 2009.

 

*General and Administrative Expense.*    Generaland administrative expense was $26.9 million for the nine months endedSeptember 30, 2010 compared to $29.7 million for the nine months endedSeptember 30, 2009. The decrease of $2.8 million, or 9.5%, was dueprimarily to our cost reduction efforts resulting in a decrease in stockcompensation expense of $1.9 million, professional fees of $1.3 million,payroll costs of $0.8 million, and other costs of $0.3 million. The decrease wasoffset by an increase in consulting costs of $0.8 million and depreciationexpense of $0.7 million. As a percent of total revenues, general andadministrative expense was 29.5% for the nine months ended September 30,2010 compared to 27.7% for the nine months ended September 30, 2009.

 

*Sales and Marketing Expense.*    Salesand marketing expense was $22.2 million for the nine months endedSeptember 30, 2010 compared to $25.5 million for the nine monthsended September 30, 2009. The decrease of $3.3 million, or 13.2% was dueto lower payroll, travel and stock based compensation costs primarily resultingfrom Company-wide cost reduction efforts in 2010. As a percent of totalrevenues, sales and marketing expense was 24.3% for the nine months endedSeptember 30, 2010 compared to 23.8% for the nine months endedSeptember 30, 2009.

 

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*Bad Debt Expense.*    Baddebt expense was $14.1 million for the nine months ended September 30,2010 and 2009. The bad debt expense we recorded was based upon an evaluation ofour historical collection experience of accounts receivable, by age, for ourvarious payor classes. Highmark’s prepayment review had a minimal impact on thebad debt expense for the nine months ended September 30, 2010.

 

*Research and Development Expense.*    Researchand development expense was $3.7 million for the nine months endedSeptember 30, 2010 compared to $4.3 million for the nine months endedSeptember 30, 2009. The decrease of $0.6 million, or 13.9%, was largelydue to lower consulting costs. As a percent of total revenues, research anddevelopment expense was 4.1% for the nine months ended September 30, 2010compared to 4.0% for the nine months ended September 30, 2009.

 

*Integration, Restructuring and Other Charges.*    TheCompany incurred restructuring costs of $3.0 million and other charges of $0.9million for the nine months ended September 30, 2010. The restructuringcosts included $2.3 million of severance and employee related costs and $0.7million of other charges related to the 2010 restructuring plan. The 2010restructuring plan included the consolidation of the Company’s sales andservice organizations, the closure of the Company’s event monitoring facilityin Georgia and consolidation with its monitoring facilities in Pennsylvania andMinnesota, and an overall reduction of administrative costs company-wide.Integration, restructuring and other charges were 4.3% of total revenues forthe nine months ended September 30, 2010. The other charges related tolegal costs and other miscellaneous items.

 

TheCompany incurred severance charges related to executive employee terminationsof $3.1 million for the nine months ended September 30, 2009.

 

*Income Taxes.*    TheCompany received no tax benefit for the nine months ended September 30,2010, compared to a tax benefit of $0.4 million for the nine months endedSeptember 30, 2009. The effective tax rate for the nine months endedSeptember 30, 2010 was 0.0%, compared to 7.9% for the nine months endedSeptember 30, 2009. The effective tax rate is 0.0% because the Company isin a net operating loss position and as a result, has included the netoperating losses in its deferred tax assets balance on the balance sheet as ofSeptember 30, 2010. The Company is uncertain as to when it may realize thebenefit of its deferred tax assets, and maintains a full valuation allowance.

 

*Net Loss.*    TheCompany incurred a net loss of $15.0 million for the nine months endedSeptember 30, 2010 compared to a net loss of $4.6 million for the ninemonths ended September 30, 2009.

 

**Liquidity and Capital Resources**

 

TheCompany’s Annual Report on Form 10-K for the year ended December 31,2009 includes a detailed discussion of our liquidity, contractual obligationsand commitments. The information presented below updates and should be read inconjunction with the information disclosed in that Form 10-K.

 

Asof September 30, 2010, our principal source of liquidity was cash and cashequivalents of $10.6 million, available-for-sale investments of $32.2 millionand net accounts receivable of $38.1 million. The Company has no short orlong-term debt and does not anticipate needing to secure financing fromexternal sources for cash to operate the business. The Company had workingcapital of $70.3 million as of September 30, 2010. We believe that ourexisting cash and cash equivalent balances will be sufficient to meet ouranticipated cash requirements for the foreseeable future.

 

The Company used $3.8 million of cash fromoperations for the nine months ended September 30, 2010. Cash was usedprimarily to fund the Company’s ongoing operations during the nine month periodthat resulted in a $15.0 million net loss, and to fund its net working capitalrequirements of $1.4 million. The Company’s working capital requirements weredriven primarily by the repayment of certain payor overpayments that wererecorded in accounts payable and a reduction in accrued payroll costs andrestructuring as a significant portion of activities initiated by the 2009restructuring plan were completed during 2010. The net loss and net workingcapital requirements were primarily offset by $11.8 million of non-cash itemsrelated to depreciation and stock compensation expense.

 

Duringthe third quarter of 2010, Highmark conducted a prepayment review of theCompany’s Medicare claims. Under Highmark’s procedures for a prepayment review,the Company must submit documentation for each claim submitted prior toreceiving payment. This is a lengthy, time consuming process. As a result ofthis review, reimbursement payments were temporarily suspended in the thirdquarter of 2010 and caused an estimated reduction in cash collections of $7.0 millionto $9.0 million. Effective October 25, 2010, Highmark completed theprepayment review and the Company anticipates cash collections will resume forits Medicare claims in November 2010.

 

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TheCompany used $3.7 million for the investment in medical devices for use in itsongoing operations for the nine months ended September 30, 2010. Inaddition, the Company used $34.7 million for the purchase of available-for-salesecurities for the nine months ended September 30, 2010. The Companybelieves that the available-for-sale investments can be converted to cash in ashort period of time, if needed.

 

Ifthe Company determines that it needs to raise additional capital, such capitalmay not be available on reasonable terms, or at all. If the Company raisesadditional funds by issuing equity securities, its existing stockholders’ownership will be diluted. If the Company raises additional funds by incurringdebt financing, the terms of the debt may involve significant cash paymentobligations as well as covenants and specific financial ratios that mayrestrict the ability to operate its business.

 

**Item 3. Quantitative and Qualitative Disclosures aboutMarket Risk.**

 

Ourcash and cash equivalents as of September 30, 2010 were $10.6 million andconsisted primarily of cash and money market funds with maturities of less than90 days. The Company also has $32.2 million of available-for-sale securitieswith maturities of less than one year. The Company believes that thesesecurities can be converted to cash in a short period of time, if needed. Theprimary objective of our investment activities is to preserve our capital forthe purpose of funding operations while, at the same time, maximizing theincome we receive from our investments without significantly increasing risk.To achieve this objective, our investment policy allows us to maintain aportfolio of cash equivalents and short term investments in a variety ofsecurities including money market funds and corporate debt securities. Due tothe short term nature of our investments, we believe we have no materialexposure to interest rate risk.

 

**Item 4. Controls and Procedures.**

 

**Evaluation of Disclosure Controls and Procedures**

 

TheCompany maintains disclosure controls and procedures designed to ensureinformation required to be disclosed in Company reports filed under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded,processed, summarized, and reported within the time periods specified in theSEC’s rules and forms.  Disclosure controls and procedures aredesigned to provide reasonable assurance that information required to bedisclosed in Company reports filed under the Exchange Act is accumulated andcommunicated to management, including the Company’s Chief Executive Officer andChief Financial Officer, as appropriate, to allow timely decisions regardingrequired disclosure.

 

TheCompany’s management, with the participation of the Company’s Chief ExecutiveOfficer and Chief Financial Officer, has evaluated the effectiveness of theCompany’s disclosure controls and procedures pursuant toRule 13a-15(b) of the Exchange Act as of the end of the period coveredby this report.  Based on that evaluation, the Company’s ChiefExecutive Officer and Chief Financial Officer have concluded that the Company’sdisclosure controls and procedures were effective as of September 30, 2010to ensure that information required to be disclosed in Company reports filedunder the Exchange Act is (i) recorded, processed, summarized and reportedwithin the time periods specified in the SEC rules and forms and(ii) accumulated and communicated to management, including the Company’s principalexecutive officer and principal financial officer, as appropriate to allowtimely decisions regarding required disclosure.

 

**Changes in Internal Control over Financial Reporting**

 

Therewere no changes in the Company’s internal control over financial reportingduring the three months ending September 30, 2010, that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

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**PART II - OTHER INFORMATION.**

 

**Item 1.  Legal Proceedings.**

 

OnMarch 5, 2010, West Palm Beach Police Pension Fund filed a putative classaction complaint in California Superior Court, San Diego County assertingclaims for violations of Sections 11, 12 and 15 of the Securities Act of 1933,as amended, against CardioNet, nine current and former officers and directorsof CardioNet and six underwriters of CardioNet’s intial public offering (IPO)consummated March 25, 2008 and/or Secondary Offering on August 6,2008 (together with the IPO, the “Offerings”). The complaint filedMarch 5, 2010 also asserted claims for alleged violations of Sections25401 and 25501 of the California Corporations Code against defendants James M.Sweeney and Fred Middleton. The plaintiff seeks to bring claims on behalf ofall those who purchased or otherwise acquired the common stock of CardioNetpursuant and/or traceable to the Company’s IPO and/or Secondary Offering. OnMarch 10, 2010, plaintiff filed an Amended Complaint that deleted theclaims for violations of the California Corporations Code.  The claims arebased on purported misrepresentations and omissions in the Registration Statementsfor the Offerings relating to alleged business decisions made by CardioNet thatwere supposedly not disclosed to investors and alleged misstatements concerningCardioNet’s business.  On April 5, 2010, all defendants removed thecase to the Southern District of California, where it is pending at docket no.10-cv-00711-L-NLS.  On April 7, 2010, defendants filed a Motion toTransfer the case to the Eastern District of Pennsylvania, which Motion toTransfer is noticed for hearing on June 28, 2010.  On April 23,2010, the plaintiff moved to remand the case to state court. On May 19,2010, the court ordered that defendants’ response to the complaint will be due21 days after the order on the Motion to Remand. On May 28, 2010,defendants filed their opposition to the Motion to Remand, and plaintiff filedits opposition to the Motion to Transfer. On June 14, 2010, plaintifffiled its reply in support of the Motion to Remand, and on June 18, 2010,defendants’ reply in support of the Motion to Transfer was filed. OnJune 21, 2010, the court found the motions suitable for disposition on thewritten motions submitted by the parties without oral argument. The Companybelieves that the claims are without merit and intends to defend the litigationvigorously.

 

Commencing on August 26, 2009, two putativeclass actions were filed in the United States District Court for the EasternDistrict of Pennsylvania naming CardioNet, Randy Thurman and Martin P. Galvanas defendants and alleging violations of Sections 10(b) and 20(a) ofthe Securities Exchange Act of 1934, as amended.  The complaints purport to bring claims onbehalf of a class of persons who purchased the Company’s common stock betweenApril 30, 2009 and June 30, 2009 and between April 30, 2009 andJuly 10, 2009.  The complaintsallege that the defendants issued various materially false and misleadingstatements relating to the Company’s projected performance that had the effectof artificially inflating the market price of its securities.  The complaints further allege that thealleged misstatements were revealed to the public on June 30, 2009 andJuly 10, 2009 when the Company made certain announcements regardingpotential lower pricing for commercial and Medicare reimbursement rates.  These actions were consolidated on September 9,2009 under docket number 09-3894.  OnOctober 26, 2009, two competing motions were filed for appointment of leadplaintiffs and lead counsel pursuant to the requirements of the PrivateSecurities Litigation Reform Act of 1995.  On December 22, 2009, the Court appointed lead plaintiff, butdenied its request for appointment of lead counsel and require lead plaintiffto file an amended motion for approval of its selection of class counsel. Leadplaintiff filed their amended motion for appointment of lead counsel onJanuary 15, 2010, which was granted on February 3, 2010. Leadplaintiff filed a consolidated class action complaint on February 19, 2010and the defendants filed a motion to dismiss on March 26, 2010. Leadplaintiff filed its opposition to the motion to dismiss on April 30, 2010.On May 13, 2010, defendants moved for leave to file a reply brief, whichmotion was granted and the reply brief was filed May 20, 2010. On August 10,2010, the Court issued an opinion dismissing the consolidated class actioncomplaint. Plaintiffs have not appealed that decision which became final onSeptember 9, 2010.

 

On April 2, 2009CardioNet entered into a Merger Agreement to acquire (“Biotel”) Inc. for$14.0 million. On July 14, 2009, CardioNet exercised its contractualright to terminate the Merger Agreement due to Biotel’s breach of certain covenantsin the agreement. On or about July 16, 2009, Biotel subsequently commencedlitigation against CardioNet in Minnesota District Count in Hennepin County,Fourth Judicial District, alleging that CardioNet had breached and improperlyterminated the Merger Agreement. CardioNet removed the action to the UnitedStates District Court for the District of Minnesota on the basis of diversityjurisdiction, and Biotel did not seek to remand the action. Biotel is seekingspecific performance and damages in an amount in excess of $10.0 million.CardioNet has counterclaimed under the terms of the Merger Agreement for itstermination fee and associated expenses; the current amount of thatcounterclaim is $1.4 million. Discovery has been concluded and the case hasbeen set for a two-week trial starting January 11, 2011. Biotel has brought amotion for partial summary judgment directed to certain CardioNet defenses andthe counterclaim; the Court has held a hearing on that motion and has taken themotion under advisement. The Company has defended, and continues to defend, itsposition vigorously. The 2010 Merger Agreement (as defined in Note 8 above)includes a Settlement Agreement that will resolve the CardioNet-Biotellitigation and result in a mutual release of all claims arising out of, inconnection with, or related to the April 2, 2009 Merger Agreement, includingthe claims in the litigation, but only if the merger contemplated by the 2010Merger Agreement is closed or if certain other conditions occur or aresatisfied. The mutual release set forth in the Settlement Agreement does not gointo effect unless and until the 2010 Merger Agreement is closed or the otherconditions occur or are satisfied. As a part of the settlement agreement, theparties have agreed to move the District Court to stay the litigation. If themutual releases in the settlement agreement do not go into effect, CardioNetwill continue to defend its position and will continue to prosecute itscounterclaim. At this time, it is not possible to determine, if the case shouldgo forward to trial, the likelihood or amount of liability, if any, on the partof the Company with any degree of certainty. Consistent with the accounting forcontingent liabilities, no accrual has been recorded in the financialstatements.

 

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**Item 1A.  Risk Factors.**

 

In evaluating an investment in our common stock,investors should consider carefully, among other things, the risk factorspreviously disclosed in Part I, Item 1A of our Annual Report onForm 10-K for the year ended December 31, 2009 and inPart II, Item 1A of our Quarterly Report on Form 10-Q for thequarters ended March 31, 2010 and June 30, 2010, as well as theinformation contained in this Quarterly Report and our other reports andregistration statements filed with the SEC. Material changes from the risk factors previously disclosed under “RiskFactors” in Part I, Item 1A of our Annual Report on Form 10-Kfor the year ended December 31, 2009 and in Part II, Item 1A ofour Quarterly Report on Form 10-Q for the quarters ended March 31,2010 and June 30, 2010 are discussed below.

 

***The Medicare prepayment medical review could negatively impact our cashposition and ability to continue current business operations.***

 

Duringthe third quarter of 2010, the local entity responsible for Medicare carrierpricing, Highmark Medicare Services (“Highmark”), conducted a prepayment reviewof the Company’s Medicare claims. This review involved an evaluation of medicalrecords and application of clinical judgment by Highmark about whether aservice is covered, and is reasonable and necessary. As a result of thisreview, reimbursement payments had been temporarily suspended in the thirdquarter of 2010 and caused an estimated reduction in cash collections of $7.0million to $9.0 million. Effective October 25, 2010, Highmark completedthe prepayment review and the Company anticipates cash collections will resumefor its Medicare claims in November 2010. If there are difficulties, orfurther delays in obtaining these reimbursements legally owed to the Company,it may have a materially adverse affect on the Company’s cash position andability to continue current business operations.

 

***The national reimbursement rate set by CMS for our mobilecardiovascular telemetry service is subject to continuing change and anyreductions in reimbursement levels would decrease our revenues and adverselyaffect our results of operations and financial condition.***

 

Reimbursementto healthcare providers, including the Company, is subject to continuing changein policies by CMS. Reimbursement from governmental payors is subject tostatutory and regulatory changes, retroactive rate adjustments andadministrative rulings and other policy changes, all of which could materiallydecrease the range of services for which we are reimbursed or the reimbursementrates we are paid. Reimbursement under the Medicare program for our services issubject to the physician fee schedule. The fee schedule is typically updatedannually.

 

Theamounts paid under the physician fee schedule are based on geographicallyadjusted relative value units, or RVUs, for each procedure or service, adjustedby a budget neutrality adjustor, and multiplied by an annually determinedconversion factor. Historically, the formula used to calculate the fee scheduleconversion factor resulted, or would have resulted, in significant decreases inpayment levels. However, in every year from 2004 through 2009, the UnitedStates Congress (“Congress”) has intervened multiple times to freeze orincrease the conversion factor.

 

OnNovember 2, 2010, CMS published The Medicare Program Final Rule establishinga national rate for the MCOTTM technology (CPT Code 93229). CMS valued the CPTcode at 20.14 relative value units. Using the formula and values currently inplace, the Company estimates the national rate to be approximately $800 perservice, effective January 1, 2011. This is an increase of approximately6% from the current local carrier rate of $754 per service that was previouslyestablished by Highmark. The values incorporated in the current formula willexpire in December 2010. If Congress does not act before December 31,2010 to continue the values, then all payments under the physician fee schedulewill be reduced by approximately 25%. If Congress does not take action topostpone the rate reduction the rate will be approximately $560. If no actionis taken by Congress and the reimbursement rate for the Company’s MCOTTMtechnology is reduced to a level lower than anticipated, the rate would have anegative impact on the Company’s results of operations. Future Congressionalaction is uncertain and future pricing methodology changes may result in reductionsor increases to the Medicare physician fee schedule.

 

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**Item 2. Unregistered Sales of EquitySecurities and Use of Proceeds**

 

Notapplicable.

 

**Item 3. Defaults Upon Senior Securities**

 

Notapplicable.

 

**Item 4. Removed and Reserved**

 

**Item 5. Other Information**

 

Notapplicable.

 

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**Item 6.  Exhibits.**

 

**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | ** **                                                                                                                                                                                  |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                        |
| 31.1                |       | Certification  of Chief Executive Officer pursuant to Rules 13a-14(a) and  15d-14(a) promulgated under the Securities and Exchange Act of 1934, as  amended.                 |
| 31.2                |       | Certification  of Chief Financial Officer pursuant to Rules 13a-14(a) and  15d-14(a) promulgated under the Securities and Exchange Act of 1934, as  amended.                 |
| 32.1                |       | Certification  of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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**CardioNet, Inc.**

 

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
| ** **                  | **CARDIONET, INC.** |
|-----------------------------|--------------------------|
|                        |                     |   |
|                        |                     |   |
| Date: November 9, 2010 | By:                      | /s/  Heather C. Getz |
|                        |                     | Heather  C. Getz, CPA |
| * *                    | * *                 | *Chief Financial Officer* |
|                        |                     | (Principal  Financial Officer and authorized officer of the Registrant) |

 

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